The Burden of Debt

Did you know the first credit card was not plastic? The post WWII era saw a boom in plastic production. In 1955, Eero Saarinen designed his famous “tulip” plastic chair. But the first credit card? It was made of cardboard – yep, flimsy, destructible cardboard. It wasn’t until 1959 that a card was offered in plastic.

Incidentally, that was the same year revolving credit was introduced. Before that such cards were really charge cards, with the whole balance due at the end of the month. But starting in 1959, you could have a card that offered to let you carry over your balance, so that you could manage your cash flow better.

Better?! Talk about flimsy getting flimsier.

I know what you want to tell me. “Yes, I know, debt is bad. Just look at Europe. Or the guy down the street losing his house because he over-extended himself. In this economy I’m all about curbing spending and paying down debt.”

Apparently, not all of you. Did you know that November 2011 saw the biggest jump in revolving debt in a decade? A decade. A decade mostly overlapping the so-called lost decade of investment non-returns. It’s ironically horrifying, or horrifyingly ironic, depending on how you want to look at it.

Why is Debt Bad?

In a word, control. The bible says, “The borrower is slave to the lender.” If you owe someone, they own a part of you. They control a part of you. Therefore you control less of yourself.

Also, debt is what contributed to our most recent financial crisis in the first place. In the housing boom of the early to mid 2000s, people were buying bigger and bigger houses, taking on bigger and bigger mortgages, in part because debt was cheap with record low interest rates. Banks made the loans, then sold them to consolidators who batched them and who then bought insurance on them to cover defaults. When the economy slowed down and people started losing their jobs, the number of defaults rose, along with the number of insurance claims. When it hit the media in September 2008 that the AIG subsidiary that was a large provider of consolidated mortgage batch insurance realized it had over-extended itself based on a flawed computer model, the whole thing crashed. We fell off the cliff. And that cliff was so high, we’re taking years to recover from the fall.

So What Do You Do if You’re in Debt?

The short answer is pay it off. The long answer is how.

Maybe you’re lucky to have enough cash sitting around to pay it all off at once. In that case, why were you sitting on it, and then paying interest on your debt? Unless you do not and will not have a way to replenish your safety cushion, it is best to use your cash to pay off debt. It’s an automatic raise in your discretionary income.

Most probably, though, you do not have that much excess cash sitting around. There are two schools of thought when it comes to paying off debt over time – the pay-off-the-smallest-debt-first approach, a la Dave Ramsey; or the pay-off-the-highest-interest-rate-debt first, a la every other financial guru with a talk show or book deal. Whichever way you choose, there are several steps to go with it.

First you need to control your spending. Limit discretionary items. Getting your nails done at the strip mall salon may be cheap, but not as cheap as doing your own. Playing golf every weekend may be fun, but is way more expensive than a mani-pedi. In some cases, meat for dinner may be discretionary. The goal is to spend less than you make, and use the excess to pay down debt.

Then pick a debt and concentrate a significant amount of your available excess income on paying that one off first. This means paying way more than the minimum. (Credit card statements now conveniently list how long it will take to pay off your balance depending on how much you pay each month.) When that debt is paid off, pick the next smallest balance or highest interest rate debt and do the same with that one. And so on until all debts are paid off. Pay the minimum on all other debts as you concentrate on the one.

This should be obvious, but don’t incur more debt. If you are spending less than you make on living expenses, this is automatic. So watch your budget and control your expenses. And do keep a reasonable amount of emergency savings to cover those unexpected…well, emergencies. Dave Ramsey recommends a $1000 “baby emergency fund”. If you have to use it, stop aggressive debt repayment to build it back up, then restart the debt pay off schedule.

If interest rates are too high such as to make your minimum payments too onerous to allow much wiggle room, do not be shy about calling the debt provider to ask for a reduction in the rate. They don’t have to honor your request, but it doesn’t hurt to ask.

If you’re really in dire straights, you can ask for a reduced payment schedule. Just expect a ding on your credit score. If you’re in even more dire straights, you can ask to see if you can settle for less than you owe. Typically, companies won’t do this unless you’re several months behind and they fear they won’t receive any of it if they don’t take your offer. You will need to first save enough for a reasonable lump sum payment, however. And expect a more significant ding on your credit score. Please only consider these tactics if there is no other option. Your conscience will thank you later.

What to Do When its All Paid Off

What do you do when all your debts are paid off (at least your consumer debts)? Pat yourself on the back and celebrate! You’ve done what most people won’t even consider doing. And don’t be afraid to tell all your friends. You may inspire, or guilt, someone into doing the same.

Please don’t negate all your hard work by incurring new debt. Of course, some debts are unavoidable. A lot of people can’t buy a house without taking on a mortgage, and this is acceptable debt if it’s within reasonable limits. A house is an appreciating investment (well, in a normal economy, anyway!). But a car? You know cars depreciate. So pay cash for it. And you should probably buy used, unless you have a significant amount of savings on hand to not notice the difference in your bank account.

While debt is currently the American way of life, including our government, don’t follow the crowd or your political decision maker. You’ll be grateful for it.